Frack Now, Pay Later: A New Era In U.S. Oil?

With oil prices now dipping close to six-year lows, the energy sector is getting thumped across the board.

The double-dip will likely cause fresh cuts to spending, drilling, and staff. Last week, Baker Hughes reported a surprise uptick in the number of rigs drilling in North America, which jumped by 10 to 884 for the week ending on August 7.

Oil prices fell even further on the news, with both WTI and Brent dropping by 2 percent to close out the week. Even though the additional rigs are a rounding error when compared to the 1,000 rigs that disappeared over the past year, the markets took the data as evidence that the supply overhang may not balance out in the near term, as new drilling could be taking place before oil production has appreciably declined.

Over the course of the last year, the companies that arguably suffered the worst were those whose business relies on drilling activity. Oilfield service companies offer rigs, drilling completions, equipment, and other services that actually allow drilling to happen. When drilling slows down, their business dries up. They bear the brunt of a market downturn. Related: Even The Saudis Need To Borrow To Survive Oil Price Slump

The unprecedented crash in the rig count North America, notwithstanding minor gains in recent weeks, inflicted damage most acutely on these oilfield service companies. With exploration facing a prolonged period of lower activity, a few service companies have come up with a novel, if desperate, approach to keep business alive.

Schlumberger and Halliburton, the two largest service firms, have offered operators the option to “frack now and pay later.” According to Reuters, the new offer amounts to the service firms acting as lenders to oil companies.

Halliburton saw its profit for the second quarter fall by more than a half billion dollars from a year before, and backed by $500 million in cash from asset manager BlackRock, Halliburton is looking “at additional ways of doing business with our customers,” Halliburton’s CEO Dave Lesar said recently. Related: Global Oil Supply More Fragile Than You Think

The “frack now pay later” model that Reuters described consists of companies like Halliburton or Schlumberger covering the cost of drilling a well in exchange for a portion of the well’s production. That is not always a preferred option for operators, who may not want to give up a share in the project and would simply opt for a conventional service contract. However, for companies that are running low on cash and may start to see their credit lines shrink, paying later for drilling today sounds like a pretty good option.

“It's just a reflection of do they want to capture more of the value themselves or would they like to outsource all the risk and potentially much more of the upside to us?” Schlumberger Chief Executive Paal Kibsgaard said when reporting second quarter results in July.

Interestingly, much of the focus is on “refracking,” in which wells that have already been fracked once are simply fracked again. Refracking old wells is less expensive than fracking new ones, and while the volume of recoverable oil varies, some of the best refracking examples produce an impressive return. Related: Shell Backs Geothermal Gun Tech

The reason that the “frack now, pay later” model may be concentrated on refracking operations is because the technique is not well known throughout the industry and is still relatively new. That has wary operators unwilling to shell out the capital for something they are unsure of, especially now that they are safeguarding a shrinking pile of cash.

But Schlumberger is confident in the approach. While reporting first quarter earnings on a conference call with investors, Schlumberger’s CEO Paal Kibsgaard extolled the market potential for refracking. “I think you're talking billions, in terms of revenue opportunities, over an extended period of time,” he said. “And I think the key here is that we're so confident in our ability to identify the right candidates and execute the refracturing work that we're prepared to take significant risks, in terms of how we go about doing this work. In many cases, if we can select the candidates, prepare to foot the entire bill for the refracturing work and then get paid back in production.”

With “lower for longer” suddenly becoming the new prevailing mantra in the oil markets, the oilfield service giants may have to increasingly cover the costs of fracking and refracking as operators scale back.